TradFi (traditional finance) is one of the newer terms to emerge from the cryptocurrency space. A combination of the words traditional and finance, TradeFi encompasses centralised institutions like retail, commercial, and investment banks. The term originated to help differentiate these from the decentralised world of cryptocurrencies.
What is TradFi (traditional finance)?
TradFi refers to the traditional finance institutions and fintech companies operating within the current mainstream financial system. These service providers are heavily centralised and regulated by governments and are primarily brick-and-mortar businesses that have provided banking and financial services for decades. They typically also carry high barriers to entry, and stringent KYC and AML processes.
TradFi includes everything from banks to hedge funds to brokerages. Examples of TradFi platforms include JPMorgan Chase and Goldman Sachs (banks) as well as fintech companies like PayPal, Square, and SoFi. All these platforms execute financial transactions in a centralised and controlled manner.
Benefits of TradFi and the mainstream financial system
Only businesses with the appropriate licences and accreditations can offer TradFi services. If these TradFi institutions' services falter in any way, customers can file complaints and receive compensation with the backing of regulatory bodies. Additionally, the amount of paperwork makes it difficult for scammers and fraudulent people to get involved, particularly with money laundering.
TradFi also assists the government by monitoring illegal spending and investments in the finance industry. In DeFi, because crypto transactions are anonymous, this is more challenging to do. By working together, TradFi institutions and governments can better achieve their goals.
TradFi has several limitations. The excessive rules and government intervention stifle development and innovation in the sector. It also keeps a significant portion of the population from accessing financial services.
In the coming years, TradFi institutions, blockchain technology, and cryptocurrencies will hopefully find a way to collaborate to create an advanced financial infrastructure that is accessible to everyone.
TradFi vs DeFi
DeFi, or decentralised finance, is a financial infrastructure that doesn't require central authorities like banks or governments. It uses blockchain technology and smart contracts to verify and authorise transactions in a decentralised, peer-to-peer manner.
One of the most prominent key differences between the two is that with TradFi services, the money is issued by the bank while decentralised finance platforms use a blockchain protocol to issue the funds to crypto users. Smart contracts then authorise the transaction between the two parties, while TradFi transactions are facilitated by banks.
Touched on above, DeFi is much more financially inclusive, providing services to anyone who can fulfil the requirements (which typically involve providing collateral). TradFi platforms on the other hand will put the applicants through rigorous checking of financial statements and credit scores.
TradFi investing has now been opened up to a much wider audience as a result of digitisation, however, it still requires intensive KYC (Know Your Customer) and AML (anti-money laundering) documentation.
TradFi vs CeFi
The centralised nature of CeFi (centralised finance) fuses together the best aspects of DeFi and TradFi. This system provides opportunities to investors who wish to use cryptocurrency-based accounts with less of the risk and might include crypto exchange services. These accounts have many benefits, with a strong similarity to traditional savings accounts.
However, the APYs (annual percentage yield) differ significantly from CeFi to TradFi platforms. You can borrow money against your crypto assets on CeFi platforms just like you would with a collateral-backed loan from a bank. This requires little to no documentation, unlike TradFi.
While some government-backed insurances cover TradFi deposits, this is not the case for CeFi deposits, making it a more risky endeavour.
How do TradFi financial institutions fit into the crypto world?
In order to stay afloat and keep up with the times, industries rely on implementing cutting-edge technologies. Today, blockchain technology and digital assets are at the forefront of a financial revolution.
If traditional financial institutions, TradFi platforms, want to maintain their relevance, they will have to eventually adopt cryptocurrencies into their systems, thus bringing them into mainstream use.
Due to traditional finance needing to comply with government regulations, the implementation of digital currencies into their platforms will likely have positive forward momentum for crypto regulation.
While currently they remain separate, there is plenty of opportunity for traditional finance and crypto platforms across key sectors like lending and insurance to join forces and merge each one's progress thus far in terms of innovation, speed, and accountability.
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